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Why FDI from Japan to India declined
Vishvanath V Desai
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May 02, 2005

Then Finance Minister, Manmohan Singh launched India's "Look East" policy in 1992 to seek out and develop economic ties with the members of Asean and major east Asian economies.

The policy was a natural extension of the reform programme aimed at opening up the economy and expanding its participation in the global economy. Perhaps there was also a hope that closer ties with east Asian economies -- that had achieved enviably high growth rates through trade -- might provide helpful insights to India.

During the decade since the Look East policy was launched, India's economic ties with east Asia made good progress. Trade grew substantially with three Asean economies -- Indonesia, Malaysia and Thailand -- as well as Korea, and their share in India's trade doubled during 1993-2003.

Trade with Singapore, on the other hand stagnated and its share was halved.  Unsurprisingly, trade with China and Hong Kong increased dramatically and its share in the country's trade expanded more than three-fold to 8 per cent during the period.

Besides increasing trade, a number of bilateral trade, investments and economic cooperation agreements have been made, especially with Thailand and Singapore, establishing broad-based economic ties with them. Discussions are underway for establishing similarly broad-based relationships with several other east Asian economies including China. 

Unfortunately, however, the Look East policy did not find Japan on its radar and failed to deepen India's economic ties with it. Trade with Japan actually declined dramatically dropping its share to one-third of its level of 7 per cent in 1993. Admittedly, the Japanese economy stagnated during much of this period and offered limited room for big expansion.

However, it is difficult to attribute such precipitous decline in trade with India to slow Japanese growth, especially when Indian trade was never more than a tiny fraction (less than 0.5 per cent) of Japan's global trade.

Failure to involve Japan and a build broad-based economic relationship with it also resulted in closing the doors on Japanese foreign direct investment.

Japanese FDI and technology have been a driving force behind the economic growth of several Asian economies since the 1960s, giving rise to the so-called "flying geese" pattern of growth.

India missed out on Japanese FDI in the pre-reform period because of its policies that discouraged FDI. Following the reforms, however, the dedicated policy instruments of Look East policy should have succeeded in attracting Japanese FDI to India.

This, however, did not happen in post-reform years, even when Japanese FDI remained robust, and continued to transfer large amounts of domestic production facilities to FDI recipient countries.

During 1993-2003, Japan's global FDI averaged at $ 50 billion a year, of which India received $ 220 million a year or less than one-fourth of 1 per cent! Even at the regional level, India received just 2 per cent of Japanese FDI. (China's share was 10 times higher at 22 per cent).

Ironically in the pre-reform period, India's economic ties with Japan were the more developed among the Asian economies.

Two-way trade often amounted to 10 per cent of India's total. By the early 1970s, several Japanese firms had entered into technical collaborations and/or joint venture arrangements with Indian firms.

Japan being the provider of largest bilateral development assistance to India (as also to the world at large), had encouraged several Japanese trading and engineering firms to establish significant presence in the country. In spite of such initial base, economic ties between the two countries actually regressed and have practically turned irrelevant since the launch of Look East.

The existing state of India-Japan economic exchange is obviously disappointing, and its continuation would be highly undesirable.

Despite its problems, the Japanese economy remains the second largest in the world, and its trade the third largest. Its demographics have spurred large-scale export of its manufacturing facilities that now accompany its massive outward FDI.

Japanese investors, including pension funds and insurance firms, are looking for capital markets that may provide higher returns than those available at home. One estimate suggests that Japanese investors hold nearly $ 200 billion of overseas financial assets.

Arguably, most of these are in the US and European markets, but small spillovers in emerging markets are also happening.

India can expect to reap significant benefits by tapping into this situation, provided it can build strong economic ties with Japan. Building such ties would, however, require departure from the limited and passive approach adopted by India in the past.

Indian policy-makers saw Japan essentially as a source of bilateral assistance, and largely ignored the trade and commercial possibilities it offered.

A fresh reminder of this attitude came a few months ago when the prime minister's first major policy speech didn't include Japan among the countries and groups with which India hoped to strengthen its relationships.

Trade officials failed to develop a differentiated approach to cultivating ties with Japan that would do justice to the potential opportunities it offered.

Apart from ritualistic visits of respective trade ministers and yearly meetings of apex chambers of commerce, little effort was made to "sell India" in Japan by reaching out to several member organisations and sector entities.

Efforts to present India's case more effectively to Japanese firms by providing information in Japanese language have been meagre. Likewise, efforts to interest Japanese "think tanks" and corporate researchers in the performance of the Indian economy have been missing.

What is, therefore, needed is to formulate and implement a determined and differentiated approach to reviving and strengthening ties with Japan. Launching of such an approach is long overdue if India is to captures the potential gains available from these ties.

Such a move would also be  timely because since the last one-two years, Japanese firms and investors have become increasingly interested in Indian economy.

A recent (Oct 2004) survey of Japanese investors by Japan Bank for International Cooperation shows a nearly three-fold increase in the number of firms that see India as a leading FDI destination in the medium and long term.

Japanese interest in the Indian economy has been sparked by a couple of developments. First, several Japanese firms and think tanks have started to feel that the FDI and production facilities transferred to China in the last decade are becoming excessive and, could make Japan over dependent on China.

This has prompted a search for alternative locations for the purpose of risk diversification. India with the depth of its industrial economy and forward-moving reform policies is seen as one promising alternative location.

Second, many Japanese firms see India's achievement of sustained growth of 6 per cent per annum over the past decade as an attractive and expanding market.

It is hoped that the present pathetic state of India-Japan ties would invite serious attention of policy makers and concerted efforts would be made to draw Japan closely into India's Look East campaign.

The author is former chief economist, Asian Development Bank [Get Quote].

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